Financial analysts’ cash flow forecasts, cash flow asymmetry and accounting conservatism

This thesis consists of three self-contained research papers in the areas of cash flow forecasts, cash flow asymmetry and accounting conservatism. The first paper (in Chapter Two) examines the factors affecting the issuance, accuracy and usefulness of analysts’ cash flow forecasts (CFFs) in Australia. The Australian market is selected due to the dominance of mining firms on the Australian Securities Exchange, the adoption of International Financial Reporting Standards (IFRS) and the prevalence of the direct method to prepare cash flow statements among Australian firms. Given the economic importance of the mining industry in Australia, the results show that analysts are likely to provide CFFs to mining firms with poor financial health and high default risk because investors have particular concerns about mining firms’ distress risk. In contrast, analysts’ provision of CFFs increases with non-mining firms which remain in sound financial health. The determinants of the issuance and accuracy of analysts’ CFFs also differ in the periods before and after the adoption of IFRS. The results add new evidence on the effect of the adoption of IFRS on analysts’ cash flow forecasting behaviours. In addition, I find that analysts’ CFFs are substantially more accurate than the forecasts generated from time-series models and analysts’ earnings forecast accuracy is improved with the presence of CFFs. The findings contribute to the debate on the merits of the presentation of cash flow statements using the direct method and will be welcomed by the Australian Accounting Standard Board, one of few accounting standard setters around the world which had previously required and now encourages cash flow statements to be presented using the direct method. Asymmetric behaviour of operating cash flows (CFO) refers to the extent to which cash flows reflect bad news in a timelier manner than good news. It was first documented in Basu (1997) along with the well-known asymmetric behaviour of earnings. Although both asymmetries are pervasive, the former has received far less attention. The second paper (in Chapter Three) of the thesis uncovers the determinants that drive CFO asymmetry. It proposes and examines two new explanations for CFO asymmetry based on sticky cost behaviours and conservatism demands. The results show that cost stickiness and the equity contracting, litigation and taxation demands for conservatism, in addition to firm life cycle, drive CFO asymmetry. However, none of these factors dominates the others, and their combination cannot fully explain the degree of asymmetric timeliness in CFO. Overall, the results provide the first insights regarding CFO asymmetric timeliness. Given that directors and managers do not always act in shareholders’ interests (Adams & Ferreira, 2007; Laux, 2008; Taylor, 2010), the Securities Class Action Litigation in the United States has been perceived to function as a potentially useful mechanism to discipline opportunistic managers and controlling shareholders as it enables individual shareholders to form a class and sue managers and directors for their breaches of SEC rules (Choi, 2004;Hopkins, 2017). However, there is an ongoing debate on the effectiveness of securities class action litigation in regulating securities markets. The third paper (in Chapter Four) examines the causal link between litigation risk and accounting conservatism. By employing difference-in-differences tests centred on a US circuit court ruling that limited shareholders’ ability to sue public firms headquartered in states within the Ninth Circuit, I find a significant decrease in conditional conservatism following the ruling for Ninth Circuit firms relative to unaffected firms headquartered outside the Ninth Circuit. The results are robust to alternative conservatism demand explanations and controls for endogenous self-selection of states of headquarters, event windows, earnings management and the pressures from external monitors. Overall, the evidence is consistent with the corporate governance role of the threat of litigation risk in disciplining managerial financial reporting practices and mitigating agency conflicts, and it adds to the debate on the role of securities class actions in regulating securities markets.